UK Housing: Rental versus Ownership – Part 2

In the first part of this article we looked at some undeniable realities of the housing market. Supply is low; demand is high; prices are high and many aspiring buyers are facing a real struggle to afford a their first homes.

Prices are certainly very daunting – currently running at over five and a half times average yearly earnings – but prospective new buyers must also face additional constraints imposed by a more cautious and tightly regulated banking sector. Mortgage-seekers are now expected to produce sizeable deposits and their ability to repay the mortgage is put under increasing scrutiny. Little wonder, then, that home ownership has fallen to its lowest rate in 30 years. Over that same period, demand for rentals has risen steadily.

A recent report from the Resolution Foundation found that, taking an average for the whole of England, the number of private rentals rose from 11% in 2003 to 19% in 2015. Moreover, in certain cities and regions, the pattern was more pronounced still. In Greater Manchester, for example, the number rose from 6% to 20%.

An important question for investors is whether this same pattern looks set to continue. The economy has been rocked by some big changes in recent weeks, not least of which has been the shock Brexit vote, and commentators now look to be very much divided over what this will mean for housing prices, supply and demand.

At one end of the spectrum are those such as Howard Archer, chief economist at IHS Global Insight. Speaking in July, he said: “Housing market activity and prices now look to be at very serious risk of an extended, marked downturn following the UK’s vote to leave the EU. This is likely to weigh down markedly on economic activity and consumer confidence, which is not good news for the housing market.”

However, in more recent weeks, views seem to have turned rather more upbeat. The Royal Institution of Chartered Surveyors (RICS) has spoken of the surprising resilience of the UK residential market, and a poll of its members suggests that, after a short term hiatus, property prices are expected to rise at around 3% per annum over the next five years. Similarly, the Bank of England seems now to foresee less risk of an economic recession, with its governor Mark Carney speaking of ‘slower growth’ rather than contraction.

What appears certain is that with the construction industry floundering, housing supply is not likely to increase in the foreseeable future. Consequently, demand will continue to outstrip supply and that should provide an invaluable safety net for investors.

This seems to be a view shared by Russell Quirk, chief executive of eMoov.co.uk, who said: “With a continuing, acute shortage of new housing being built and a growing population… the demand versus supply imbalance, and the prospect of even lower interest rates will underpin the market.”

The new Prime Minister, Teresa May has pledged to address the current housing shortage but then almost every PM in recent history has made a similar commitment without having any meaningful effect. Given capacity restrictions in the construction industry and its seeming reluctance to build at a time when house price growth is uncertain, there must be a limit to how much government policy can influence the rate of house completions.

Moreover, even if the supply side of the equation could gradually be changed, the scale of the current imbalance means that it could still take many, many years for prices to come down to affordable levels. The charity Shelter recently commented that house prices had become “completely out of step with average wages”; it would take an unprecedented surge in house building to make an impact on that.

A more credible risk could come from an ailing British economy. If inflation were to rise – a likely consequence of the post-referendum fall in the value of sterling – then this could gradually create a sense of falling standards of living. This would be compounded if it were to coincide with rising unemployment and reduced wage growth. In that event, then people would feel poorer, less confident and less able to commit to house purchases. In turn, this could gradually slow the rate of house price growth or, as some argue, it could even lead to some level of price deflation.

It’s important to note that the situation is entirely hypothetical. Such a situation may never materialise, and even if it did, the downside for investors might be relatively small. For one thing, falling demand for house purchases invariably translates into rising demand for rentals. For another, the effects would only be temporary and, after a lull, the continuing shortfalls in housing supply might be expected to set prices back on their traditional upward course.

Most economists seem to agree that the Brexit vote will constrain growth in the short term but, generally, the longer term forecasts for Britain’s economy are good. The Bank of England appears to be expecting the UK to avoid recession in 2016 and 2017. Thereafter, unless the terms of Brexit produce some really momentous surprises, it’s likely that the country will return to a more normal pattern of growth. Mark Carney and many others have voiced their faith in the underlying strength of the British economy and, if recent indicators such as the RICS survey are to be believed, the UK housing market is likely to prove similarly robust.